A Project of The Annenberg Public Policy Center

Hedge Fund Managers’ Tax Rates


Sen. Bernie Sanders says firefighters, police officers, nurses and truck drivers all pay higher effective tax rates than hedge fund managers. That’s accurate for some in those occupations, but it’s not the case across the board.

Single firefighters, police officers and nurses who earn the median salary in those middle-class-sounding jobs, and with no children and standard income tax deductions, would pay higher effective tax rates than hedge fund managers, once we factor in payroll taxes. But a single truck driver earning the median salary would pay a slightly lower rate than the typical hedge fund manager. And once we consider other hypothetical situations — adding in a dependent child, or a nonworking spouse, or both — the hedge fund manager pays a higher effective rate than the other occupations at the median pay level.

If our firefighters, police officers, nurses and truck drivers earned some of the top salaries for their professions, they would pay a higher effective tax rate than our hedge fund manager. That’s still the case for all except the truck driver if they had one dependent child and filed as head of household.

Sanders has a point that some in the professions he cites would pay higher effective tax rates — once we factor in payroll taxes — than what a hedge fund manager (or someone who earns money through investments rather than wages) might pay. He’s objecting to the ability of those who manage investments for a living to pay capital gains tax rates, which are lower than most marginal income tax rates and substantially lower than the top income tax rate.

This issue was highlighted by investor Warren Buffett, CEO of Berkshire Hathaway, in 2011, when he said that he paid a lower effective tax rate than the other workers in his office. Back then, the top capital gains rate was only 15 percent — it’s now 20 percent — but people who “make money with money,” as Buffett put it, can still pay lower effective tax rates than those who make their money through payroll jobs. It depends, however, on an individual’s circumstances, as we’ll show.

Sanders’ Talking Point

Sanders, who’s running for the Democratic nomination for president, has been making some version of this claim for months. In May, he tweeted: “It is not acceptable that millionaire hedge fund managers are able to pay lower effective tax rates than truck drivers or nurses.”

More recently, he has added Buffett to his claim. In July, he said on CNN’s “State of the Union”: “When you have Warren Buffett, one of the richest guys in the world, telling us that his effective tax rate is lower than his secretary’s or truck drivers’ or nurses’, of course that has got to change.”

And then, in an Aug. 30 interview also on CNN’s “State of the Union,” he switched to firefighters and police officers, saying: “When you have hedge fund managers, as Warren Buffett reminds us, paying an effective tax rate lower than firemen or police officers, that’s got to change” (see the 10:38 mark).

We have repeatedly asked the Sanders’ campaign for its calculations behind these claims, but we haven’t received a response. We will update this article if we do.

We could not find an instance of Buffett talking about truck drivers, nurses, etc. He did speak in some general terms in his 2011 New York Times op-ed, saying, “But if you earn money from a job, your [effective tax] percentage will surely exceed mine — most likely by a lot.”

We found in 2011 that that certainly wasn’t always the case. Just as it isn’t always the case now that investment fund managers would pay lower tax rates than the professions Sanders cites.

Let’s start with hedge fund managers, or private equity fund managers.

Both types of funds are investment pools. Private equity funds — like Mitt Romney’s Bain Capital — acquire companies, try to improve them and then sell them. Hedge funds, a 2014 Congressional Research Service report explains, “follow many strategies, investing in any market where managers see profit opportunities.”

In either case, fund managers can invest their own money in the funds, and they charge fees to outside investors. One of those fees is a percentage of a fund’s earnings. That’s known as “carried interest,” and it’s taxed as a capital gain under IRS rules.

The top capital gains rate — for income above $413,200 for individuals — is 20 percent. Plus, there’s a 3.8 percent Medicare surcharge tax on investment income for those earning more than $200,000. That would make a wealthy investment fund manager’s tax rate about 23.8 percent.

It actually could be lower or higher than that, depending on the amount of carried interest and also the amount of standard wage compensation that fund managers typically receive. They also normally get a share of an asset management fee that’s taxed as ordinary income. But there is no accepted median pay for fund managers, and Steven M. Rosenthal, a senior fellow at the Urban-Brookings Tax Policy Center and an expert on the carried interest rules, advised us to use the 23.8 percent rate for our purposes.

Investment fund managers can earn millions, or hundreds of millions, and once compensation reaches such levels, the income that’s not taxed at the higher capital gains rate matters less and less. The 2014 CRS report noted that: “According to Alpha magazine, the top 25 hedge fund managers earned $14.4 billion in 2012.”

So, let’s compare the tax rates of firefighters, police officers, nurses and truck drivers to our fund manager’s 23.8 percent.

Effective Tax Rates Chart

Firefighters. According to the Bureau of Labor Statistics’ May 2014 report on occupations, the median pay of firefighters in the Unites States was $45,970. A single firefighter earning that amount, with no dependent children and taking the standard income tax deduction, would pay $4,889 in income taxes. (We used H&R Block’s 2015 tax calculator to determine federal income tax liability.) Our firefighter would then pay 7.65 percent in payroll taxes (6.2 percent for Social Security and 1.45 percent for Medicare), with the employer paying the same amount. We count the employer portion as being paid indirectly by the employee — as Warren Buffett, and economists, would do — and then count the employer taxes as indirect income to our firefighter, too. We then divide total taxes paid by total compensation to get an effective tax rate of 24 percent, just higher than our hedge fund manager.

We explained our method to Roberton C. Williams, the Tax Policy Center’s Sol Price fellow, who agreed that was the correct way to calculate an effective tax rate, including payroll taxes.

If our median-pay firefighter had one dependent child, filing taxes as head of household, the effective rate would drop to 20 percent. And the rate for a married firefighter with one child and no income from the spouse (filing jointly) would be 17 percent.

There are many more scenarios. Firefighters who own their homes would likely pay lower income tax rates with itemized deductions. Others would have spouses who also earn income; others would have more than one child. And half of the firefighters in the U.S. earn less than the median annual pay, meaning their effective tax rates would be near or below the 23.8 percent investment fund manager rate.

Police officers. The median annual pay for police officers was $56,810. Using the same calculations for a single person with no dependents and a standard deduction, that police officer’s effective tax rate would be 26 percent. Once our police officer gains a child or a nonworking spouse, that rate falls below a hedge fund manager’s, to 21 percent to 22 percent, respectively.

Again, half of U.S. police officers earn below the median pay. And, of course, half earn more. In the San Francisco metropolitan area, the average pay is $101,040, an amount that’s above the 90th percentile for police pay. That effective tax rate, with only standard tax deductions, is 31 percent for a single person.

Nurses. Registered nurses had the top median pay of the four professions: $66,640. That salary would have a 28 percent effective tax rate for a single person with no dependents. Even our nurse, though, drops below the hedge fund rate once we add a child, a nonworking spouse or both. If the average nurse in San Francisco, however, were a single parent taking standard deductions, he or she would pay a 29 percent effective rate on a salary of about $128,000.

Truck drivers. The median pay for truck drivers was $39,520, which isn’t enough for a single person with no dependents and standard deductions — the scenario with the highest tax rate — to pay a higher rate than the hedge fund manager. That hypothetical truck driver pays 23 percent. (To be precise, the rate is 23.4 percent, just below the 23.8 percent hedge fund manager’s rate.) If our truck driver were married with one kid and no income from a spouse, the rate drops to 13 percent.

Drivers in the Peabody, Massachusetts, area earn the highest average pay for a metropolitan area — $57,250 — for an effective rate for a single/no dependents person of 26 percent. If that truck driver had one dependent child, however, the rate would drop to 21 percent.

If hedge fund and private equity fund managers had to pay income tax rates on what’s now considered capital gains, that 23.8 percent effective tax rate would go up. As we mentioned, most marginal income tax rates are higher than that, with individual income between about $37,000 and $90,000 at the 25 percent rate for 2015. The top rate, which starts after income surpasses $413,200, is 39.6 percent.

Sanders isn’t the only presidential candidate to claim that the tax treatment is unfair — Republican Donald Trump said in late August that “the hedge fund guys are getting away with murder.” And the senator has a point about the effective tax rates of those in much lower-paid occupations. But there are plenty of firefighters, police officers, nurses and truck drivers who should not be fooled into thinking they pay higher rates than the wealthy hedge fund managers.

— Lori Robertson